Taxation will be the dominant issue in the election, and Labor's policy to stop the refund of franking credits will be top of the charts. But most voters have no idea how the imputation system works. The word 'imputation' means credit given for something, and the imputation system was introduced to prevent double taxation of company dividends. Dividends from Australian shares are the only Australian income stream where profits are taxed before you receive them. The franking credits are simply a credit for tax paid by the company on behalf of the investor. If you invested in direct property or a property syndicate, or received interest from a bank account, the income from that investment would be paid to you in full and you would pay tax on it at your normal marginal rate. Think about two investors - one receives a franked dividend of $700 plus a franking credit of $300 for tax deducted by the company. The other receives a $1000 distribution from a property syndicate and no tax is deducted by the company paying it. If they were both retirees on zero taxable incomes, the franking credit of $300 would compensate the first investor for tax deducted by the company paying the dividend and under present policy would be refunded to him by the tax office. Therefore, both investors would receive $1000 net. An analogy would be a person who is a PAYG employee and has tax taken out of their pay. When they do their tax at the end of the year, losses from activities such as negative gearing may reduce their taxable income. They will then get a refund from the tax office of part of the PAYG tax deducted by the employer. Now, with numbers, you can always offer different interpretations. Shadow Treasurer Chris Bowen was recently quoted as saying: "Think about a nurse who earns $67,000 a year - we make her pay $13,000 in tax. Yet a retired shareholder with a substantial balance in superannuation could receive $67,000 in income with his fund paying zero tax. On top of that he expects the government to write the fund a cheque for $27,000. That is not fair." But there are many anomalies that could be described as "not fair". Why should Chris Bowen get 49% back from the government on tax losses if he negatively gears an investment property, while the nurse gets back just 34.5%? Why should some politicians be allowed to access their superannuation before they turn 60? Our superannuation system is designed to encourage people to invest for their retirement, which means people with money in super will be often be better off tax-wise than people out of it. But our retiree could get around the franking credit changes by transferring his self-managed super fund to a retail or industry fund, where the franking credits will be used to pay contributions tax and earnings for members in accumulation phase. There is only one group who will be left stranded. They are the self-funded older retirees who are not in super and can't contribute because of their age. For example, think about a self-funded retiree who has invested in shares in their own name, not through a super fund, and whose income from dividends is $67,000 a year. Their taxable income would be $95,714, after adding on $28,714 in franking credits. Tax on that $95,714 would be $24,825 ($22,911 tax, plus Medicare levy of $1914) leaving a refund of just $3889. That's way different to the $27,000 the Shadow Treasurer is bandying around. Furthermore, the retiree's effective tax rate is nearly 30% - the nurse's is 19.4%. Is that fair?

Franking credits: what's fair?

Dividends from Australian shares are the only Australian income stream where profits are taxed before you receive them. The franking credits are simply a credit for tax paid by the company on behalf of the investor.

Taxation will be the dominant issue in the election, and Labor's policy to stop the refund of franking credits will be top of the charts. But most voters have no idea how the imputation system works.

The word 'imputation' means credit given for something, and the imputation system was introduced to prevent double taxation of company dividends. Dividends from Australian shares are the only Australian income stream where profits are taxed before you receive them. The franking credits are simply a credit for tax paid by the company on behalf of the investor.

If you invested in direct property or a property syndicate, or received interest from a bank account, the income from that investment would be paid to you in full and you would pay tax on it at your normal marginal rate.

Think about two investors - one receives a franked dividend of $700 plus a franking credit of $300 for tax deducted by the company. The other receives a $1000 distribution from a property syndicate and no tax is deducted by the company paying it.

If they were both retirees on zero taxable incomes, the franking credit of $300 would compensate the first investor for tax deducted by the company paying the dividend and under present policy would be refunded to him by the tax office. Therefore, both investors would receive $1000 net.

An analogy would be a person who is a PAYG employee and has tax taken out of their pay. When they do their tax at the end of the year, losses from activities such as negative gearing may reduce their taxable income. They will then get a refund from the tax office of part of the PAYG tax deducted by the employer.

Now, with numbers, you can always offer different interpretations. Shadow Treasurer Chris Bowen was recently quoted as saying: "Think about a nurse who earns $67,000 a year - we make her pay $13,000 in tax. Yet a retired shareholder with a substantial balance in superannuation could receive $67,000 in income with his fund paying zero tax. On top of that he expects the government to write the fund a cheque for $27,000. That is not fair."

But there are many anomalies that could be described as "not fair". Why should Chris Bowen get 49% back from the government on tax losses if he negatively gears an investment property, while the nurse gets back just 34.5%? Why should some politicians be allowed to access their superannuation before they turn 60?

Our superannuation system is designed to encourage people to invest for their retirement, which means people with money in super will be often be better off tax-wise than people out of it.

But our retiree could get around the franking credit changes by transferring his self-managed super fund to a retail or industry fund, where the franking credits will be used to pay contributions tax and earnings for members in accumulation phase.

There is only one group who will be left stranded. They are the self-funded older retirees who are not in super and can't contribute because of their age.

For example, think about a self-funded retiree who has invested in shares in their own name, not through a super fund, and whose income from dividends is $67,000 a year. Their taxable income would be $95,714, after adding on $28,714 in franking credits. Tax on that $95,714 would be $24,825 ($22,911 tax, plus Medicare levy of $1914) leaving a refund of just $3889. That's way different to the $27,000 the Shadow Treasurer is bandying around.

Furthermore, the retiree's effective tax rate is nearly 30% - the nurse's is 19.4%. Is that fair?

Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. noel@noelwhittaker.com.au